MSC Industrial Direct Co Inc (MSM) 2014 Q1 法說會逐字稿

Good morning, and welcome to the MSC Industrial Direct first quarter 2014 conference call.

All participants will be in listen-only mode.

(Operator Instructions)

I would now like to turn the conference over to John Chironna, Vice President of Investor Relations and Treasurer.

Please go ahead.

Thank you, Amy, and good morning to everyone.

I would like to welcome you to our fiscal 2014 first quarter conference call.

An online archive of this broadcast will be available one hour after the conclusion of the call and for one month on our home page, at www.MSCdirect.com.

During today's call we will refer to various financial and management data in the presentation slides that accompany our comments, as well as our operational statistics, both of which can be found on the Investor Relations section of our website.

Let me reference our Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

Our comments on this call, as well as the supplemental information we are providing on the website, contain forward-looking statements within the meaning of the US securities laws, including guidance about expected future results, expectations regarding our ability to gain market share and expected benefits from our investment in strategic plans, including the BDNA acquisition and expectations regarding future revenue and margin growth.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements.

Information about these risks is noted in the earnings press release and the risk factors in the MD&A sections of our latest annual report on Form 10-K filed with the SEC, as well as in our other SEC filings.

These forward-looking statements are based on our current expectations and the Company assumes no obligation to update these statements.

Investors are cautioned not to place undue reliance on these forward-looking statements.

In addition, during the course of this call we will refer to certain adjusted financial results, which are non-GAAP measures.

Please refer to the tables attached to the press release and the GAAP versus non-GAAP reconciliations to our presentation, which contain the reconciliation of the adjusted financial measures to the most directly comparable GAAP measures.

I'll now turn the call over to our Chief Executive Officer, Erik Gershwind.

Erik, please go ahead.

Thanks, John.

Good morning, and thank you for joining us today.

Also in the room with us is Jeff Kaczka, our Chief Financial Officer.

I'll begin by stating that I'm very pleased with our progress over the past quarter and with our performance against the plan that I laid out on the last call.

This morning I'll cover the current operating environment, where we're seeing some positive signs of stabilization, our recent developments, where we're seeing solid results, and our progress with key infrastructure and growth initiatives, including BDNA, where we remain on track.

Jeff will focus on our financial results and provide our fiscal second quarter guidance, and I'll then conclude with an update of our expectations for the year, which are in line with what I shared in detail on our last call.

We'll then open up the call for Q&A.

I'll now turn to the environment.

Over the past quarter, we've seen definite signs of stabilization and potential improvement in the manufacturing economy.

While not near the strong growth levels indicated by recent ISM readings, feedback from our manufacturing customers confirms the current theme of stabilization and gives us some cause for greater optimism about 2014.

This sentiment is reflected in recent metal working-related surveys, such as the metal working business index.

Readings for the past three months have hovered around 50.

While only indicative of a flat metal working environment, it's nonetheless a significant improvement over the below 50 readings through most of last year, and it's consistent with what we're hearing from customers.

Current order flows and inventory levels are steady, and the prospects exist for improved order flow and growing backlogs as we move through the new calendar year.

In addition a budget resolution in Washington should hopefully reduce uncertainty for our commercial customers and those directly impacted by federal spending.

Overall, we continue to see that our core customer segments in heavy metal working are still lagging the broader industrial economy.

Nonetheless, it's fair to say that we're incrementally more positive about the outlook than we were a quarter ago.

Turning now to our results, a combination of an improved environment, along with sustained share gain momentum yielded organic growth of 5% for the quarter on an average daily sales basis.

We were also encouraged to see growth rates build sequentially through the quarter, from just under 3% in September, to over 5% in October and roughly 5.5% in November after excluding an accrual to refine our estimate for direct shifts.

Manufacturing grew at 5.1% for the first quarter and improved sequentially through the quarter.

Non-manufacturing grew at 3.9%, and also showed sequential improvement.

Government continued to decline and had a 1% year over year negative impact to our growth rate.

Our second quarter forecast assumes roughly flat growth for the government sector, which is primarily the result of easier comps rather than improving average daily sales.

Should the budget resolution have a significant near-term impact on spending we'd expect performance of our government sector to improve.

We also continue to benefit from strong performance in our national accounts program, which is growing considerably above company average.

The growth is coming both from improved penetration of existing accounts and new account signings.

Since the first quarter ended, we have a full month of fiscal December and just two days of our fiscal January under our belts.

As a reminder, our fiscal December closed on Saturday, January 4. Interpreting growth rates is particularly tricky this time of year, especially this year when Christmas and New Year's fell on Wednesdays, increasing the negative holiday impact on our growth rate.

Furthermore, the recent bad weather around much of the country makes forecasting second quarter growth even more difficult than it normally is at this time of year.

We posted organic average daily sales growth of around 3% in our fiscal December.

Our sense is that the decline in monthly growth rate from November is largely attributable to holidays and weather, as growth rates tailed off considerably towards the end of the month.

The last few days of the month were particularly soft relative to our expectations, as the midwest and then the northeast were severely hit by winter storms.

Unfortunately, that trend has carried into this week.

On Monday, for example, our Elkhart CFC didn't open until 2:00 PM as a result of severe weather conditions.

I can't remember the last time that happened, and it's indicative of the impact on businesses across the Midwest.

We typically find that we recoup a portion, but not all, of the lost revenues in the days that follow severe weather.

Given the tight timeframe with respect to this call, we have extremely limited visibility so it's tough to say how this month plays out.

The revenue guidance Jeff will provide assumes that January and February return to growth rates that resemble October-November and the first part of December and then most of the weather-related revenue loss is not recouped.

I'll now turn to the execution of our FY14 plan.

On the last call, we laid out our plans in terms of three sets of initiatives: infrastructure investment, growth investment and BDNA.

I'm pleased to report that we're on budget and on schedule with each of the three.

And I'll now give you a brief progress report.

As I mentioned last time, we completed our co-headquarter initiative in Davidson, North Carolina last quarter.

The roughly $4 million in incremental annual operating expense is now fully in our run rate.

We currently have about 190 associates located in Davidson and will begin receiving the related tax incentives in calendar 2015.

We continued construction on our fifth customer fulfillment center in Columbus, Ohio and it remains on schedule to open later this calendar year.

As envisioned, the operating expense impact will continue to grow in FY14 and extend into FY15 as we staff and fill the building with inventory in preparation for go live.

We're on track to incur approximately $4 million of incremental operating expenses in FY14, inclusive of the build in staffing and the very beginnings of depreciation expense.

The build and staff is already underway.

CFC head count was up roughly 100 people from the fourth quarter to the first quarter, largely in support of the integration of BDNA facilities, but also to support Columbus.

In fiscal 2015 the Columbus-related operating expenses will step up by another roughly $5 million, primarily related to depreciation expense.

The excess head count will gradually work its way out of our operating expense as we move through FY15.

Our project to relocate our primary IT data center began and is going quite well.

We're on track to complete the migration over the next couple of quarters.

Project-related expenses of $3 million to $4 million for the year began hitting the P&L in the first quarter and step up to their peak level in the second quarter, gradually coming down over the rest of the fiscal year.

I'll now turn to our growth initiatives, which continue fueling our share gain momentum.

The vending program added roughly 4 points to our growth in the first quarter.

Vending signings remain strong, and in fact exceeded our expectations for the quarter.

We view this as a function of the strength of the program's value, along with our customer's ongoing need to find ways to streamline their supply chain.

Our vending improvement plan is also well underway, continued gaining traction and vending program margins are improving as a result.

Most of the improvement is coming on the operating expense line in the form of productivity savings.

As the program typically results in higher levels of planned spend from our customers, we anticipate it will remain a gross margin headwind for the foreseeable future.

ECommerce reached 46% of sales for the first quarter, as compared to 42.8% a year ago, and 45.7% last quarter.

Our new site is fully rolled out and continues to receive positive feedback.

We continue to make important enhancements to our platform that we view as critical to maintaining our leadership position.

As a result, eCommerce remains an important part of our growth investment program.

Sales force expansion is on track to add between 5% to 7% to our field sales head count for the year.

While our first quarter head count increase was modest, we expect an additional 25 to 30 net new hires in the second quarter, putting us on track to hit our annual target.

We're pleased with our candidate pipeline and with the talent that we're bringing in to date.

Finally, SKU expansion.

We added over 40,000 SKUs to our web offering in the first quarter and now have approximately 725,000 available on our website.

We're on track to add roughly 150,000 SKUs during fiscal 2014.

We're encouraged by the growth prospects of this program in the quarters to come, as the newly introduced SKUs mature.

The program is also quite efficient in its use of capital, as we have careful stocking criteria that keep inventory commitments moderate.

Turning now to our integration of the BDNA business, it continues to go well.

After many months of decline, revenue growth at BDNA turned positive in the first quarter and remained there in December.

The improvement in growth rates can be attributed to, first and foremost, improved execution in customer service, and secondly from the very early stages of cross-selling synergies.

We also remain encouraged by new account signings, the benefit of which is not yet reflected in current growth rates.

The integration plan of BDNA remains on track.

We've closed one distribution center already, with two others in progress as we speak.

We're also moving the Cleveland headquarters to our new Davidson location by September 2014 as planned.

Additional cost synergy capture is also going as expected.

Overall, we remain on track to achieve our targeted cost synergy run rate of $15 million to $20 million by the end of fiscal 2015 and to achieve our $0.15 to $0.20 accretion range for this fiscal year.

Looking to the future, as each month passes we grow increasingly confident about the growth prospects of the business.

After a few quarters of integration, we're now beginning to ramp up investments for future growth in BDNA.

In the coming quarter, we'll begin to increase sales force head count from current levels and we'll also begin investments in marketing and in the expansion of BDNA's value-added services offering.

This will begin to show in the form of sequential increases in operating expenses and we're confident that these investments will yield payback in the form of improving growth rates and earnings in the quarters to come.

These investments, by the way, are fully in line with our original plans.

Looking beyond BDNA, we continue to see acquisitions as an important element of our growth story over time.

That said, in the near term we anticipate being even more selective than normal when evaluating potential deals.

Right now our focus is on successfully executing the initiatives currently in front of us, in order to realize the sizable payoff that will result.

I'll now turn things over to Jeff to discuss the financial results in greater detail and provide our second quarter guidance.

Thanks, Erik, and good morning, everyone.

The stabilization in the market environment and our sequential sales growth improvement throughout the quarter are encouraging developments that contributed to our earnings per share exceeding our guidance.

We continued executing our various growth and infrastructure initiatives and we're pleased with the progress made thus far.

BDNA integration continues to go well and its first quarter results are slightly better than expected.

So let me go through the fiscal first quarter results in more detail.

I'll continue to speak in terms of our reported results and our adjusted results, which reflect the exclusion of nonrecurring Davidson relocation and BDNA integration costs.

Our reported sales growth on an average daily sales basis was 17.5% compared to the same period last year.

This includes a full quarter of BDNA sales.

Excluding BDNA, our organic sales growth on an average daily sales basis was roughly 5%.

And that growth rate continued to benefit from customers within our vending program, which contributed roughly 4 points of growth.

On the website this morning you hopefully saw the footnote to our November sales figure which stated that we refined our accrual for direct ships this quarter.

The impact of that change increased our organic sales growth for November by 2.3 points and for the fiscal first quarter by 0.7 of a percentage point.

This was a one-time catch-up that will have no future impact on our growth numbers.

The change had an immaterial impact on the first quarter's earnings.

In regard to gross margin, we posted 46.4% for the quarter, just below the midpoint of our guidance of 46.5%.

This primarily reflects two dynamics at play and both are positive for the business.

First, our national accounts program is growing faster than the rest of the business, putting some pressure on our gross margin.

And second, the growth of BDNA and the mix of the business supported higher gross margin.

As compared to the same period last year, margin was up roughly 50 basis points, also driven by BDNA's higher margin.

Our reported EPS for the quarter was $0.93, or $0.99 on an adjusted basis, which excludes roughly $0.04 for BDNA integration costs and about $0.02 for Davidson relocation.

The $0.99 was above our guidance of $0.92 to $0.96 and reflects the bottom line impact of sales above the top end of the guidance range, as well as our management of operating expenses.

Finally, the tax provision came in at 38.3%, just above the 38.2% tax rate we guided to for the quarter.

Turning to the balance sheet, our DSOs were 47 days, up slightly from last year's Q1, and we're pleased that our inventory turns improved to 3.46 from the previous quarter level of 3.39.

From cash flow perspective, we continue to generate significant levels of cash as evidenced by our operating cash flow of $104 million.

We decided to use a portion of our cash to buy back shares during the fiscal first quarter.

As we've said in the past, our approach to share repurchase is an opportunistic one.

In total we repurchased 1.45 million shares for $111 million, an average price of $76.64 per share.

In addition we pay the increased dividend that we announced at the end of our fiscal year totalling $20.9 million and incurred capital expenditures and infrastructure investments of $33 million.

CapEx was in line with our plan and our expectation for total year CapEx of slightly over $100 million remains on target.

As of the end of the first quarter, we had $322 million in debt, mostly comprised of the $246 million outstanding on our term loan, and a $50 million balance on our revolving credit facility.

We closed the quarter with $48 million in cash and cash equivalents and our current cash balance now stands at $23 million.

Let me turn to our guidance for the fiscal second quarter of 2014.

Consistent with last quarter, this guidance will include the impact from the BDNA operating results and exclude the nonrecurring BDNA integration costs, as well as any remaining relocation costs associated with our Davidson facility.

We expect revenues to be between $660 million and $672 million.

On an organic basis, the expected ADS growth is about 4.5%.

The midpoint of our guidance range assumes that January and February return to growth rates similar to those we saw in October, November and early December.

It also assumes that most of the weather-related revenue loss incurred over the past week is not recouped, which is typical of what we historically see.

We expect gross margin to be in the range of 46%, plus or minus 20 basis points, 40 basis points sequential decline from first quarter is mainly driven by typical second quarter seasonality, and by the headwinds resulting from our growth programs, like vending and national accounts, offset in part by strategic gross margin initiatives.

We expect adjusted operating expenses will increase at the midpoint of guidance by $7 million versus the fiscal first quarter.

The increase breaks out as follows.

Roughly $1 million is attributable to an increase in spending in BDNA, driven primarily by the growth investments that are described earlier, as well as increased staffing to support expected volume growth.

That leaves a $6 million increase in the base business.

Nearly $2.5 million is purely the calendar year reset of payroll-related tax expenses that occurs every year.

The remaining $3.5 million is primarily related to our key growth and infrastructure initiatives.

While we do manage the business closely, I did want to highlight that this spending is key in driving our future growth and we expect fully to remain on plan in terms of our strategic initiatives.

Those include sales force expansion, which will yield around 35 hires through the first half of the year, and distribution center hiring to support the Columbus CFC and the BDNA integration.

As a point of reference, our CFC head count will be roughly 160 people higher by the end of the second quarter than it was at the end of fiscal year 2013.

Project spending on the data center move is also a factor in the sequential second quarter lift.

As we indicated on the last call, our fiscal second quarter adjusted operating margin is expected to be the low point for FY14.

There are two key drivers converging in the second quarter.

First is that we expect this to be the lowest revenue quarter of the year due to normal seasonality, the holiday impact and weather.

And second, we expect to see our largest sequential lift in operating expenses excluding volume-related costs.

As a result, the implied adjusted operating margin at the midpoint of our guidance is about 13%.

Looking beyond the second quarter, we expect operating expenses to continue to build in support of our growth and infrastructure initiatives.

However, with the exception of the volume-related variable costs, which are purely a function of sales levels, we expect base operating expenses to grow more moderately in the second half of the year.

In fact, the majority of the $2.5 million incremental payroll-related tax expenses in our first quarter should subside in the back half of the year, which will offset continued modest increases in growth and infrastructure spending.

We remain fully on track to achieve full-year 2004 (sic-"2014") adjusted operating margin in the range of 14% to 15%, assuming low to high single-digit organic revenue growth.

Finally, our adjusted EPS guidance is $0.83 to $0.87, reflecting the current market environment and our increased spending on infrastructure and growth initiatives.

It also assumes a tax rate of about 38.2%.

Our earnings guidance, of course, includes BDNA operating results and excludes the integration costs associated with the acquisition and Davidson relocation costs.

These impacts reported EPS by a total of approximately $0.06.

Also, the BDNA business is expected to be accretive by about $0.03 in the second quarter.

So in summary, we exceeded our EPS guidance for the first quarter, thanks to stronger sales growth and ongoing expense management.

It's encouraging that the pickup in sales growth that we saw at the beginning of the first quarter strengthened throughout the quarter and continued into the second quarter.

And our investment programs are going according to plan, and that, along with the improving demand, will provide us growing leverage into the future.

Thanks, and I'll turn it back to Erik.

Thanks, Jeff.

Before we turn to your questions, I want to confirm the framework that we shared with you on our last call and I want to emphasize that we're on track with our commitments.

Let me highlight a couple of key points that we made.

We expect full-year 2014 adjusted operating margins to be in the range of 14% to 15%, should organic revenue growth be somewhere in the single digits.

The further we move up the curve from low to high single digits, the closer we would get to 15%.

We expect the second quarter to be the low point for the year, with respect to adjusted operating margins.

And finally, with respect to earnings, mid single-digit organic revenue growth is about the breakeven range for EPS growth.

Double-digit EPS growth would only occur if we moved into the high growth scenario of double-digit organic growth.

Our first quarter performance and our second quarter guidance put us right on track with what we laid out last quarter.

In the first quarter, we achieved adjusted operating margins of a shade over 15% on 5% organic revenue growth.

Adjusted op margins will decline in the second quarter on slightly lower revenues, and we continue to see the second quarter as the adjusted operating margin trough for the year due to the seasonal effect of the holidays, weather disruptions and the anticipated ramp in our spending.

Pulling back from the near term and looking at the bigger picture, I remain very excited about the story that is building here.

We're putting in place the infrastructure that sets us up for the next run of growth.

We're executing on the share gain programs that will fuel top line growth, particularly as manufacturing recovers.

We're executing on the BDNA integration and growth plan, which creates a new platform of growth to complement our base business.

All of this makes for a story of tremendous earnings leverage as we move beyond the near term into FY16 and beyond.

I'd like to thank our entire team for their hard work and their dedication in executing this plan, and we'll now open the line for questions.

(Operator Instructions)

Sam Darkatsh, Raymond James.

Good morning.

This is Josh filling in for Sam.

Thanks for taking my questions, and congratulations on the quarter.

Hello, Josh.

How are you?

Good.

I wanted to get the assumptions for share count straight with the guidance.

Could you break out what the guidance is for share count, and also tell us how much is remaining on the buyback authorization?

Do we have the share count total?

It was -- actually, the share count --

Yes, the share count -- the share repo authorized program was 4.3 million shares before the buyback.

So, subtract from that the 1.45 million shares.

So, that would give you your outstanding amount.

What is that, like, 2.5 million, 2.3 million?

What is that?

Sorry -- 2.9 million.

Sorry.

And as far as the share count, most of the shares were bought back in November, and we do it on a weighted average basis -- on a daily basis.

So, there wasn't a huge impact in the Q1.

In fact, the impact was about $0.005.

I can get you the exact share counts afterwards, Josh, if you want to follow up with me.

Okay.

That all makes sense.

Thank you.

You know, actually, we assumed 62.1 million shares.

Okay.

There you go.

Got it, thanks.

For Q2.

Okay.

And then, I know there's a lot of moving parts in December, but if maybe we back away from the last week or so when there was noise with weather and holidays, can you give us a sense of how pricing is looking, now that you're a few months into the last big book price increase, and what some of the puts and takes have been as it relates to price and volume?

Yes, sure, Josh.

It's Erik.

I'll give you a perspective on both what we're seeing from a demand standpoint, and I'll touch on the pricing environment.

I think from a demand standpoint, what you sense from us is we're encouraged by the sequential improvements we saw through the back half of calendar 2013, the beginning of our fiscal year.

Our perspective is: Our share gain momentum continues, and the only difference that you saw from Q1 to prior quarters was an improvement in the manufacturing, and particularly metal-working manufacturing environment.

As we described, it's not like it's booming, and we don't see it as the ISM would indicate.

But certainly the environment went from what was a pretty negative environment over the past 12 to 18 months to one of stabilization.

In terms of the holidays, the weather, yes, hopefully you also sense from us that this is a really, really tricky time to be interpreting growth rates in December.

I will tell you that for much of the -- the first part of December looked an awful lot like October and November from a growth standpoint.

And the back half of the month, particularly the end of the month, you had two things going on.

One was the holidays of Christmas and New Year's Day falling on a Wednesday -- is the most extreme negative impact we could see from a holiday effect.

And then number two, add on top of that really lousy weather in several parts of the country that was widespread.

So, you saw effectively a combination of holidays plus weather pulled growth rates from what was in the 5% neighborhood down to the 3% neighborhood.

Okay.

So, that's the story on demand environment.

But absent that factor, we feel pretty good about what's building.

And what we did moving forward is baked into our guidance forecast -- is January and February returning to the 5%-ish range that you saw in October and November, which is consistent with our characterization and our customers' characterization of the environment as stable.

So, that would be the demand environment.

With respect to pricing, I would tell you that the big book price realization was solid.

It was consistent with what we've seen over the past few years.

I would still characterize the pricing environment as modest.

And, as you know, the way we look at pricing -- there's two primary drivers that we use to assess a pricing environment.

One being: What's happening on the supplier front?

Two being: What's happening on the customer front and sensitivity to pricing?

Right now, when we put those together, we would still characterize the Q1-Q2 period as modest.

Thank you very much.

Ryan Merkel, William Blair.

Hello, everyone.

Good morning.

Good morning, Ryan.

So, first off, wanted to dig into the drivers of the improving growth.

Certainly vending continues to be a driver, but were there any end markets or product categories that are standing out as -- where you're seeing the biggest improvement, or is it broad based?

Ryan, what I would say is: From an end-market perspective, I think the color I would add is, in general, as we described metal working -- our core end markets, the metal-working end markets are still lagging the broader industrial economy.

So, I think that dynamic holds.

I think what you've seen is the water level come up, and certainly it's an improved picture, but still lagging.

In terms of bright spots, I'd point you to a couple of areas by channel.

Certainly vending and eCommerce are the shining stars.

And I think that's a function of the value add that those programs are bringing to customers in a time when customers are really looking to streamline supply chain.

And then from a market perspective, I'd point to our national accounts program as to what's been sort of disproportionately outperforming the Business.

And I would tell you there: I think two things going on.

Primarily what we're seeing is, I believe, improved execution.

And that's both with respect to account penetration and new account signings.

I will tell you, historically, national accounts have served as somewhat of a leading indicator for us of what will happen across the broader customer base.

So, I think we're hopeful that that's the case here.

Right now, though, when we dig in on our national accounts performance, I think it's weighted, to date, more towards execution than it is to market.

But that does give us some cause for -- the historical correlation gives us some cause for optimism.

Okay.

That's helpful.

And then, I want to dig into the price again because by my math price added a little less than 0.5 points year over year to the growth rate.

And I thought price was running at kind of 3% in October and November.

So, what am I missing?

Yes, Ryan, are you referring to -- in the websites that -- the growth decomposition?

Yes.

Okay.

So, one thing to realize there is that is a -- so, if you're looking at that $1 million roughly, that's a combination of price plus discounting plus mix.

So, that's customer mix.

That's product mix.

There's all sorts of movement under the covers.

What I would tell you is that the way -- we have some detailed measurements on price realization, and we're seeing strong realization, consistent with what we've seen over the last few years.

Okay.

So, just mix is an offset there.

Then you said discounting is an offset, too.

Wouldn't that hurt the realization?

It would.

I'd tell you that mix -- mix is a big part of what's going on as well, though.

Okay.

So, more mix.

Okay.

Then, last question, you said expenses will ramp more modestly.

This is outside of variable expenses in the second half.

So, of the $12 million to $15 million in infrastructure growth spending planned for the year, what annual run rate are you running at -- are you assuming for the fiscal second quarter?

Ryan, it's Jeff.

Let me just give you a sense maybe going down the infrastructure investments, and you could get a sense.

We had said it would be an additional $12 million to $15 million in the year during the last call associated with the infrastructure.

Davidson is at full run rate right now.

In terms of the CFC for Columbus, we'd begun ramping there.

There's where we'll see a little bit more of a ramp in terms of infrastructure expenses as we go out.

And a good deal of the IT data center expenses have already been incurred, and will be incurred through Q2, and then that will subside as we go out.

As far as the growth investments, though, we will continue to ramp in areas like the sales force expansion, and a lot of that will take place in Q2, and continue in the second half of the year, and then SKU expansion, vending and so forth.

But it will be a more modest increase sequentially from quarter to quarter, again, excluding the volume-related increases.

Perfect.

Very helpful.

I'll get back in line.

Thanks.

Matt Duncan, Stephens, Inc.

Good morning, guys.

Congrats on a good quarter.

Hello, Matt.

Hi, Matt.

So, Erik, I'm wondering if we could maybe dive a little bit more into the increased -- improvement in your tone that I think you're purposefully making sure you get across here.

How much of what you guys are seeing that's making you more positive is sort of just end-market stabilization versus talking to your customers, their optimism, and what you're hearing from your customer base on their expectations going forward?

So, Matt, here's what we're trying to get across.

It's not booming.

It's not great.

But it's better than it was for the last 12 to 18 months.

And I think that's very consistent with when you look.

So, there's still a big divergence between the ISM and the metal-working market.

So, if you look at the metal-working indices, there's still a wide gap.

When we speak to customers, there's still a big gap between what customers are saying and what the ISM reading suggests.

So, what you're hearing is improvement relative -- we've been, for the past 12 to 18 months, in a manufacturing market where, with respect to our core end markets and metal working, things are pretty soft.

So, it's better.

It's stable.

And I think that's the way our customers would characterize things.

There's a couple of things that give us sign of pause, and signs of optimism for 2014?

Sure.

The budget resolution is one that we mentioned that we're hopeful will add more certainty, both to government and commercial customers.

But, in general, the more positive tone that you're hearing is more along the lines of: Things are stable and not declining.

Okay.

So, following up on the month-to-month progression, and I get that this is a little bit guess work, but is there any way to try and quantify the impact that you're seeing from the weather?

Can you look at December in a way that you can look at how many locations -- how many sales offices you had that were down for so many days, or customers that were down, and try and break out?

If I look at the 5% drop in daily sales growth excluding the benefit you had in November from the accrual change, how much of that do you think you can attribute to weather versus other things like holiday timing?

Matt, it's almost impossible for us.

In fact, I'd say virtually it's impossible to split out.

Because of the timing of the weather, and that we don't have enough days under our belt post holidays, post weather now to see how things rebound -- hopefully weather calms down a little bit across the country -- it's really impossible for us to parse out.

So, the way I think about it is: The difference between the 5% and the 3% is a combination of holiday, plus weather disruption, and tough for us to break it out any further.

Okay.

Understood.

And then last thing for me on the buyback.

Is that something you guys would see yourself continuing to do?

Jeff, you did say that was sort of an opportunistic action.

Stock is obviously up a bit from where you made those purchases.

So, would it be safe to assume that that was probably something that you did that one time, and we're likely not going to see it again?

Or do you still feel like there's a good opportunity to buy more of your stock here?

It's one of the elements of our capital allocation and return to shareholders.

And you could see: We've always said we take a balanced approach in terms of where we put the capital.

Just look at the past year.

We did the largest acquisition in the Company history.

We followed it up with a dividend increase.

We just did the share repurchase and, of course, we're investing significantly in the organic growth of the Business.

And I would expect a balanced approach going forward, and an opportunistic approach to the share repurchase.

Okay.

Helpful.

Thank you.

Adam Uhlman, Cleveland Research.

Hi, guys.

Good morning.

Good morning, Adam.

Thanks, again, for all the added disclosure.

It's very helpful.

I guess my first question was a clarification on the pricing environment.

Did you happen to take your normal December price increase?

We did not, no.

We took no pricing action, other than what we disclosed about our big book increase.

Okay, got it.

And the idea there is just: There's not cost push from the suppliers?

Yes, we had talked about, Adam -- in terms of the P&L impact, the purchase cost headwind realized through our P&L is certainly mitigated.

And then looking out the windshield, again, we're characterizing the environment as modest still.

Okay, got it.

And then, as I think about the inventory additions for the rest of the year, you're adding a lot of SKUs; you're getting better turns.

It sounds like there's some more to come.

Could you help me understand how you think about the inventory dollars as the year progresses or your turn goals?

Yes, sure, Adam.

It's Erik.

I think what you're seeing on the inventory front is -- and you're rightfully pointing it out.

It's an area where I think we're executing well, and what you're seeing is the result of some operations improvements that we've made within our purchasing area to drive turns up.

What I would tell you: If you're looking forward, the only significant factor -- the SKU additions -- I made a point of mentioning that the inventory -- the way the program is designed, I think it's done very smartly, where we're bringing inventory in only when we have a very high degree of confidence in the sales activity of the SKUs.

So, I wouldn't see a major headwind there.

The only headwinds you'd really see going forward that would impact turns at all would be the build we're going to do for Columbus, which will, over time, work its way out of the system.

That will be a temporary spike.

Other than that, though, pretty much steady as she goes.

Okay, got it.

Thanks.

Brent Rakers, Wunderlich Securities.

Thanks.

Good morning.

Wanted to follow up on the last question.

I guess the lack of a mid-year price increase, and maybe if you could talk about what the ramifications would be for gross margin trends during the second half of the year?

Yes, Brent, it's Erik.

So, again, pricing environment's modest.

No mid-year today.

Remember: We can do a mid-year pretty quickly.

So, I wouldn't rule anything out for the back half of the year.

All we're giving you is what we see right now.

It's certainly possible that we could take some modest pricing.

You've got the sense of what we're guiding for in the second quarter, and I think we would characterize the sequential erosion from Q1 to Q2 as pretty moderate, all factors considered.

Right now, and obviously we'll give you guidance on the next call about the next quarter gross margins.

But if you asked us right now, if we peeked around the corner, looked at Q3, Q3 would look relatively stable with Q2 down slightly, but relatively stable.

And I think the key thing to remember is: All of this is sort of factored into our perspective on the op margin range of 14% to 15% for the year.

Okay, great, Erik.

That's helpful.

Maybe on BDNA for a second -- when you look through the outlook there, could you maybe talk about where the headcount is now before you start re-investing in the Business, and maybe where the headcount was at closing date?

Sure.

And are you talking about -- Brent, are you talking about field sales headcount, total headcount?

Total headcount, please, Erik.

Total headcount: I'm going to have to get back to you.

We're going to have to get back to you.

We'll follow up, Brent.

I don't have it offhand.

Generally -- without the numbers, let me just give you sort of a directional sense of where we're at.

Obviously, one would expect that support-related non-customer-facing headcount is going to come down over time.

That is part of the cost synergy number that's in the model, okay?

And directionally where we're at -- field sales headcount, which is really the growth driver portion of the Business, is a shade under 700 now -- not materially different than it was.

That's the number that, over time, we're going to expect to see grow.

I think like we see on the MSC base business, we see a lot of runway for sales force expansion, so that's the number that I expect to grow, and that will begin to tick up in the second quarter, albeit slightly.

Okay, great.

And then, I guess just, Erik, one follow-up on that last question.

Related to the $1 million of additional investment spending targeted for the second quarter on the BDNA, can we assume that that's almost exclusively additional sales force adds?

No, it's actually divided.

Let me touch on BDNA.

Just going to, Brent, give you a high-level walk on BDNA.

So, $0.05 accretion Q1, down to $0.03 in Q2.

The $0.02 is essentially -- $0.01 of that is the lower sales volumes in Q2 that are seasonality.

They see the same thing we see on the MSC side.

And then $0.01 of that is the money that you're referencing that's reinvestment into the Business, along with -- we're also anticipating higher sales levels in the back half of the year.

So, there's a small piece of the money that's supporting volume support for the back half of the year.

A piece of it is beginning stages of sales force expansion, although I'd tell you that's early.

And then the other two were the pieces that I mentioned, which are marketing investment and investment into some of their value-added offerings.

Okay.

That's perfect.

Thank you, Erik.

David Manthey at Robert W. Baird.

Thanks.

Good morning.

Hi, David.

Maybe if you guys could address -- while we're on BDNA here, could you talk about functionally what's been done to date there, and what's on the docket for 2014?

The reason I'm asking is: On the last call, you had mentioned that the better-than-expected performance at BDNA was one area of potential upside for the numbers.

I'm just wondering what that might look like, where that outperformance might come from, so if you could help us with what you've done and what you're going to be doing in 2014 would be helpful.

Sure.

It's Erik.

So, right now, David, I think the headline is: BDNA basically on track.

I would say the $0.15 to $0.20 accretion range, the $15 million to $20 million synergy run rate in 2015, right now, assume that's on track.

And we expect to fall within those ranges on both as planned.

In terms of what's happening with the Business, there's really a few components going on.

I would call step one around improving execution and improving customer service in that Business.

Step two -- and these are not sequential necessarily, but three sets of things.

That's initiative 1.

Initiative 2 would be integration, which would be integration of the distribution centers as described, and integration of the headquarters location into Davidson as described.

And initiative 3 would be growth planning.

So, I think to characterize where we are now, we're well underway on initiative 1, which is improve customer service, improve execution, which is servicing existing accounts and signing new accounts.

Integration plans are also underway, and that's what's driving the synergy realization, both on the cost side and the very early stages on the revenue side.

And then just entering now sort of initiative 3, which would be growth planning, which was what I just described on the million dollar growth investment.

So, I think with where we're at, we're encouraged.

The Business, if you look back, had been trending for the last year or so as a decline -- a mid-single-digit decliner.

That's moved to a low-single-digit grower.

And I think the gap there is essentially the first two things.

It's the customer service and execution, and very beginnings of cross-selling synergy.

All right, thank you, Erik.

Just finally, in terms of these SKU additions that you're making, are you targeting your existing or similar customers with these products?

Or are there new verticals you can go after?

And I'm wondering: Does the number of customers you have -- the number of active customers -- does that go up or does the mix of non-manufacturing, for example -- does that change materially as we go forward based on these SKU additions?

David, I would say: Philosophically, these SKU additions are not all that different in terms of how we viewed prior SKU additions is -- which is they are targeted -- for the most part, they are targeted both largely at share-of-wallet gain and account penetration is sort of priority one.

And certainly a lot of these SKUs do give us the ability to move into new end markets.

But I would tell you first and foremost on share-of-wallet gains.

And as I describe, I think we're using some very smart techniques in how we're harvesting and mining some of our transactional data, historical data, customer data, to get high-performing SKUs into the mix.

Great.

Thank you.

Eli Lustgarten, Longbow Securities.

Good morning, everyone.

How are you, Eli?

Thank you for taking my questions.

Hello?

We're here.

Hi.

Good morning.

Just one clarification, because I think you gave guidance.

Did you say 62.1 million shares basic was what you were assuming for the year?

Was that the basic number you had?

Diluted.

That would be diluted.

62.1 diluted?

Correct.

62.1 million diluted shares in our assumption for Q2 guidance.

Okay.

Thank you.

Now, can we talk about the operating expense?

You said it will be up $7 million, ex whatever happened to sales numbers in the second quarter.

And then it moderates.

But with depreciation coming on for the extent of next year, are we looking at roughly $3 million to $5 million per quarter of incremental expenses for the next couple of quarters as you go into 2015?

Some of the guidance, not (inaudible) but looking third and fourth, and into 2015 of what the sequential operating expense number goes up, excluding the volume change.

Are you speaking in terms of depreciation associated with the CFC?

Well, you gave a $7 million in the quarter, but only $1 million of that is depreciation.

Then you get $2.5 million from the payroll, and $3.5 million from growth and manufacturing.

That's a sequential number.

I'm trying to get is: What is that sequential number in the third, fourth and into 2015?

Depreciation goes up, payroll sort of disappears for a while, and you still have the rest of the base increment.

I'm just trying to get an idea of what should we figure the incremental operating expense numbers on the second half of the year into 2015 grow at, excluding the volume number?

Eli, it's Erik.

I'm going to jump in for a second.

I think the way to think about it: We're not yet prepared to give you a specific sort of quarter-by-quarter OpEx look because there are variables on timing, on what happens with volume.

What we did want to get across is, number one, the annual framework that we gave you in terms of an op margin is intact.

Number two, the Q2 -- Q2 is going to be the low point in op margin for the year, and in part because it's the highest OpEx build.

And what we were trying to get across is the fact that -- don't take the plus $7 million in sequential OpEx and assume that Q3, Q4 are each then a plus $7 million.

That if you look from Q2 to Q4 and drew a line, that we expect, absent volume increases, which we hope come in spades, but that absent that, that it would not be a straight line taking the $7 million trend and running it out.

But would it potentially stay flat or slightly up from the 2Q run rates, is really what I'm looking at?

We still expect it to go up.

Okay.

Most of the commentary you have prior really set up 2014 at a modest earnings decline for the year.

You are now sounding a lot more optimistic, particularly with the organic growth potential that you're seeing there.

Does that give you more confidence that you should be looking more at flat to probably modestly up year in 2014?

I think, Eli, what we want to get across on the call is: We're on plan.

I think the framework we laid out the last call -- we still feel like we're intact.

We felt like, from an earnings growth standpoint, mid-single digits -- somewhere in the mid-single digits is the break-even range for where earnings growth are flat.

We still feel that's the case.

And depending upon how optimistic one wants to get about what the revenue trajectory and the environment, you could draw your conclusions on where you take that with earnings.

But from our standpoint, on plan.

All right.

Thank you very much.

Sure.

Thanks.

Hamzah Mazari, Credit Suisse.

Hello, everybody.

This is Flavio.

I'm standing in for Hamzah today.

How are you doing?

Morning.

How are you?

Doing great.

Most of my questions have been answered already.

But if you just could give us a sense, or comment a little bit on how the OEM side is tracking relative to the MRO side, especially as manufacturing seems to be doing better recently.

Yes, we gave you so -- Flavio, for our first quarter, and this is sort of consistent trending, but for Q1, manufacturing was up a shade over 5%.

Non-manufacturing, a shade under 4%.

And remember: Non-manufacturing is weighed down a little bit by one of the -- of the 24%-ish that's non-manufacturing, about 8% of that, or 8% of the 24% is government that's been negative.

That makes sense.

Within manufacturing, has OEM started to give signs of recovery as well, or is it more on the MRO side?

Yes, so, we did see -- that's a good point.

The 5% did grow sequentially through the quarter, so we're certainly encouraged by that.

But, yes, as I said, I would still characterize the sort of hard -- heavy manufacturing environment as stable, and not certainly as a straight line up right now.

What you're hearing from our tone is: Stable this quarter is a lot better than negative, what it's been for the last year or so.

That makes sense.

That's very helpful, guys.

Thank you.

Our last question comes from John Inch, Deutsche Bank.

Thank you.

Good morning, everyone.

Hello, John.

Hi, John.

Good morning, guys.

Erik, were you alluding to -- when you were describing pricing, were you alluding to a third-quarter expectation on gross margin that was comparable to the second quarter?

I wasn't quite sure what you were suggesting with respect to margins in the third quarter, based on what you were describing earlier in the call.

John, what I was -- yes, I was.

Yes, so, let me just -- I'll make sure I get it straight for you.

What I was responding to was -- the question had to do with pricing, lack of mid-year, influence on Q2, and then looking to the second half of the year.

And obviously, you know our drill.

We tend to give the gross-margin guidance one quarter at a time.

What I said was: If you ask me right now to peek around the corner at what I saw for Q3, probably a slight decline.

But relatively stable, slight decline with where we are in Q2 would be what we see right now.

All subject to change, but that would be the look around the corner.

Okay.

So, that's sort of what I thought.

Now, to get to the 14% to 15%, kind of your expectation for the year, if we go from 15% down to 13%, how do you -- like, how does third quarter and fourth quarter fill in?

Like, is it an expense control, or you're just assuming that volumes -- volumes drive gross margins.

So, is the rest of this to get to your own op margin guidance, Erik?

Is that because expenses come down?

It's a little bit of a point around Eli's question.

Yes.

Good question, John.

So, what I would tell you is: Last call, when we gave you the framework, our implicit assumption was that gross margins are plus or minus relatively stable, not a big difference versus prior year.

I'm talking about even versus prior year, not a big difference.

The big change going from Q2 to Q3, for instance, is going to be the revenue levels.

And particularly, growth rates certainly; a lot more growth would help a ton.

But there's a seasonality impact.

So, Q2 is the low -- from an absolute sales dollar standpoint, Q2 is the absolute low point.

Q3 tends to be -- historically, is a higher absolute number.

That gives some leverage.

So, even if OpEx were to go up the same as it did in Q2, we get more leverage based on the sales being higher.

Historically, some of the seasonal pattern is driven, if I'm not mistaken, by the price dynamic.

So, if you're not able to take -- if you didn't take a price increase, and you did do the three, but your realization is sort of -- it's flat based on your disclosure.

Doesn't price traditionally, Erik, kind of fade over the course of the year?

Meaning: You start out with a catalog, and you kind of get that initially but then, for lots of different reasons, mix or national accounts or whatever, the price fades over the course of the year.

I'm just curious: If that's not really an expectation set, are you banking on something else perhaps, like maybe incremental -- significant incremental BDNA contribution or something like that?

So, John, two elements to the question.

I think one thing I'd get across is that we do -- even absent price, we would anticipate seeing a lift in absolute sales Q2 to Q3, market conditions remaining constant.

We would expect that.

And the same thing we would expect to happen on the BDNA side, similar seasonal pattern there, which, as you could imagine, would help improve the contribution from BDNA.

So, that would be the volume story.

On pricing, look, we're still hopeful that we can capture some -- even if it's modest, some mid-year pricing, if it's modest.

But are not anticipating -- in order to achieve the 14% to 15% -- you are correct that our normal seasonal pattern is: Margins will peak in the first -- absent pricing, peak in the first quarter, and then the headwinds will take over through the course of the year.

So, two things I'd point out.

One is: Look, we're hopeful that maybe there is an opportunity for some modest mid-year this year.

Two would be: The purchase cost headwinds that we were calling out last year, it was a sizable to the sequential headwind is not there the way it was last year.

We talked about it was going to work its way through.

It has.

So, that leads us to believe that it should be a more stable picture than maybe it was in prior year.

Okay.

That's very helpful.

Maybe one more.

I appreciate the timing of holidays.

But do you guys -- I mean, given this winter weather, don't you actually sell winter sort of seasonal products that -- I know certainly Granger does.

They sell summer and winter products that they're prospectively maybe getting a boost to offset some of the Midwest weather disruption in other areas of the country?

Or is that less a factor given your metal-working mix?

Good question.

And yes, you are correct.

The answer is both.

We do.

So, our rock salt, and there's certain items that we'll sell like crazy.

So, there is a little bit of a tailwind there.

That generally is more than offset by the headwind of: Given our customer and product mix, we're selling into manufacturing, and what we lose is more than what we gain.

Perfect.

Okay.

Thanks very much, guys.

Okay.

So, I'd like to thank everybody for joining us today, and for your continued interest in MSC.

Our next earnings date is April 9, and we look forward to speaking with you over the coming months.

Thank you.

The conference has now concluded.

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